The restructuring debate in the electric industry has focused on nuclear assets at risk for "stranding" under deregulation, while another issue has largely eluded public scrutiny: accumulated deferred federal income taxes (ADFITs). ADFITs represent money that utilities have received from ratepayers to cover federal tax expenses not yet actually recognized and paid. In sheer dollar amounts, ADFITs run well into the tens of billions; the amount might rival the sum of recoverable stranded costs.1 As such, ADFITs might well supply the pot of gold needed to liberate true competition from the ransom of stranded costs.
Under an accounting process called "normalization," the component of utility operating costs represented by federal income tax expenses and recovered by utilities through rates is computed as if the income reportable on the utility's federal return equaled income reported for regulatory purposes (book income). In fact, utilities historically have reported a lower income for tax purposes than book income, because the Internal Revenue Code (Code) permits utilities that use normalization accounting to claim accelerated depreciation and other deductions and credits not recognized for ratemaking purposes. Hence, the federal taxes actually paid by utilities have remained significantly less than the federal tax reimbursements they have received from ratepayers.2 Utilities have been recording the difference on the liability and equity side of their balance sheets to ADFIT (or, in the case of the investment tax credit, accumulated deferred investment tax credits (ADITC)).3 Utilities have not been required to segregate the resulting billions of dollars of ADFIT advances, nor have they been otherwise precluded from using them as operating capital (em merely to reduce rate base by their amount.